Osborne should ignore Moody's and put the brake on cutbacks

Thursday 16 February 2012 12:32 BST

Squeeze: But our AAA rating is at risk whether we adopt fiscal tightening or loosen the corset

As Sir Mervyn King reminds us, digging ourselves out of the hole we're in is going to be a long job. Inflation may be on the way down but growth - for all of the Bank of England's glass-half-full predictions about next year - will be hard to come by.

The UK economy needs all the help it can get. So let's give ourselves a break and stop listening to the likes of ratings agency Moody's, which put the UK's AAA credit rating under threat this week.

Since the sub-prime debacle of the boom years, when agencies were giving gold-plated ratings to whatever trash the investment banks made up in return for huge fees, it's amazing anybody still gives them the time of day. But having missed the bubble on the way up, they're more than happy to administer the kicking on the way down.

The Chancellor, of course, seized on its comments as justification for his own deficit-slicing strategy, but this ignores an inherent contradiction within the agency's statement. We're told that the main risks to the UK's AAA status come from "increased uncertainty over the pace of fiscal consolidation" because of "materially weaker" growth prospects, as well as the increased threat of another turn for the worse in the eurozone.

But then it adds that the risks of dangerously high debt over the next few years are also partly the "by-product of a necessary fiscal consolidation programme" and acknowledges the "possible impact of any future cutbacks on short-term growth". Moreover, the latest cutbacks announced last November give the Government a "reduced capacity" to absorb economic or fiscal shocks without further slippage in the schedule.

To be clear: this deficit reduction programme, while "necessary", is threatening or at least contributing to lower growth prospects, potential slippage in the deficit programme, and hence the chances of us losing our coveted AAA rating. But in the same breath, Moody's says that any signs of slipping political commitment to austerity may result in the loss of the rating as well.

Fiscal tightening or loosening the corset, the result seems to be the same. As one baffled City economist said to me: "We're damned if we do and damned if we don't. The message seems to be sit tight, fingers crossed and hope the eurozone doesn't blow up."

Ironically, Moody's intervention comes with UK gilt yields close to record lows, driven down by our dire growth prospects and the Bank of England's presence in the market buying up billions in gilts. And the ratings agency itself gives the lie to the Coalition's ridiculous argument that the UK is another Greece in the making, as it points out that the average maturity of UK debt is 14 years. Even if the markets did take umbrage at a loosening of the deficit-cutting strategy, this longer maturity shields us from the immediate impact: the real reason why Osborne won't go there is political embarrassment rather than economic good sense.

A very rough and ready way to work out the direct impact of austerity is to compare the average rate of government spending growth between 2000-2010 - around 2.3% a year - with the Office for Budget Responsibility's forecasts for 2012-2016, which show a 2.1% annual decline on average. Take the difference between the two numbers and multiply it by government spending's share of the economy - 23% - and this gives you one percentage point a year in lost potential growth from the government sector.

How we could do with that extra 1% right now. I'm not arguing that cuts aren't necessary over the long term: they are. But plenty of experts - including the IMF - tell us not to front-load austerity. With the current clouds over Europe, the present pace of the plans looks suicidal: Osborne needs to get growth going before mounting an assault on the deficit. Ignoring the fate of our AAA status - and Moody's - would be a good start.